The different types of brokers

The different types of brokers

Like many of you, I did not understand for a long time the difference between the different types of brokers in the foreign exchange market. The term broker is also often used wrongly because it is not always the case.In fact, we have to differentiate them according to their business model. Currently, there are three main types of actors on eForex, the last two of which are the most accessible to individuals: - ECN  - The pure brokers - The market makers

ECN

The ECN (electronic communication network) are marketplaces. All transactions are executed directly on the interbank market. This is called the 'no dealing desk'. Thus, as with Euronext for the equity market, the order book is displayed. Participants are therefore counterpart to other participants because as you know to buy, it takes a seller in front. The ECN are matcher ordersof their different customers. You probably ask yourself the same question that I asked myself at the beginning, how do you do when there is no one in front? It's very simple, they use liquidity providers (LP). These liquidity providers are banks that allow clients to have significant liquidity and to obtain tight spreads under normal market conditions. The prices are displayed in real time and therefore reflect the prices quoted by the different banks. This allows full transparency of the market by giving access to information to all participants. Each liquidity provider constantly displays its prices and can tap into the liquidity displayed. The disadvantage is that spreads are not fixed, volatility increases during important economic announcements. The spread can reach 15 pips sometimes on the EUR / USD. The ECN has long been reserved for institutional but some brokers now offer this service to individuals. In the latter case, ECNs themselves play the role of liquidity provider. Liquidity is therefore reduced compared to a supplier such as a bank.  The main benefit of operating type is that you remain anonymous and that the ECN can not know which account the order is coming from. So we can not deal with you, I'll come back to this point later. This is a great benefit especially for scalpers. You can also decide to place an order between the price offered and the asking price. The ECN are remunerated by commission on the volume handled by traders. Often this is around $ 10 to $ 20 per million processed.

Pure brokers

Pure brokers operate in much the same way as ECNs, with the difference that the liquidity offered to their clients is assured in all cases by a liquidity provider. This supplier is a bank which ensures a significant liquidity. Pure brokers are therefore simply intermediaries between customers and the bank. The prices are those displayed by the bank on the interbank market, not in all cases. Indeed, the pure brokercan be rewarded in two ways. The first is the transaction volume achieved by its customers ($ 4 to $ 5 per million processed for example). It is often the one that is privileged and allows the broker to reduce its spreads. The second is the so-called markup (eg adding a pips to the best offer and removing a pip from the best bid of its liquidity providers). The pure broker then earns a pip on each transaction. The pure brokers do not take positions against you as they are by their autohedger liquidity provider. Even if, unlike ECN , your anonymity is not kept, scalping is allowed because the broker is not at risk even if you keep your position for a few seconds. In addition to greater liquidity, pure brokers offer advantages over ECNs, particularly in customer relations and services provided. You will frequently have a range of superior tools, tips, analysis, signals, subscription to trading systems, managed accounts.

Market Makers

The market makers finally, are nothing other than a few individual brokers. They most often display fixed spreads, but the main difference with pure brokers is non-price transparency. The market maker can decide to quote outside the prices of its suppliers of liquidity (LP) at any time, this is particularly the case during ads, some brokers literally freeze their prices while the banks move at the same time .. but because of fixed fixed spreads this is a normal thing. You should know that when your Broker offers you 3 pips at the time of a Non farm PayrollMeanwhile, half of its LP quotes spreads of 10 or 20 pips. The only way for him to adjust his risk while maintaining a fixed spread is to freeze his price or on the contrary to shift it suddenly to the other side of the range. The Market Makers are probably the types of intermediaries who are most developed in recent years. The fixed spread and the guaranteed stops are for many. They have found a formula that simplifies the Forex for the particular client, or even the institutional that wants to do a little FX without being its main activity. The market maker takes a position contrary to yours to cover himself. He will be against you most of the time in his book because it is he who mediates between you and the liquidity provider. Risk management is ensured by the risk book which gives the position in volume on each currency. In reality, below a certain amount (around 50K), the market maker offsets orders internally without routing them to the market. So if you are "too" profitable, you affect their "profitability" ... All market makers do not practice this kind of operations but it happens. Above 50K, it is either the provider of liquidity so the bank that covers the transactions in exchange for a commission, or the market maker himself. To get paid, he can either charge a commission on the volume of transactions or increase by one pip the spread offered by his liquidity provider. This spread on the EUR / USD is 2 pips. If a broker has a spread of 2 pips and does not charge any commission, it is often that he gets paid thanks to the losing trades of his customers. Most market makers do not accept scalping because they do not have time to cover themselves. When accepted, quotations are the prices offered by the bank and therefore the spread becomes variable. This is done on a special scalping account.

Conclusion

ECN  : Advantages: price transparency; order book visible; possibility of placing an order in the price range; authorized scalping; anonymity when placing orders, very competitive spreads; do not play against the customer Disadvantages: Variable Spreads; less liquidity; risk of slippage; fixed commissions Pure brokers  : Advantages: Significant liquidity; price transparency; many services offered; authorized scalping; The broker never plays against the client; Very competitive spreads Disadvantages: Variable Spreads; commissions  Market makers  : Advantages: Fixed spreads; No commission; No slippage; significant liquidity  Disadvantages: Scalping prohibited; erroneous listing; if only broker book, win a lot and you will not be welcome; can play against the client